Mandatory Gratuities Are Not “Tips” But May Qualify as Commissions Under the FLSA, Fourth Circuit Holds
Agreeing with the district court, the Court of Appeals for the Fourth Circuit has concluded that the mandatory service charges imposed by a restaurant on dining parties of six or more were not “tips” under the FLSA. However, the Court of Appeals reversed and remanded the trial court’s determination that the FLSA’s “commissioned salesperson” overtime exemption applied, as well as the trial court’s determination that the tip pool in question was valid. Tom v. Hospitality Ventures, LLC, 2020 U.S. App. LEXIS 37074 (4th Cir. Nov. 24, 2020).
Ãn Asian Cuisine (“Ãn”) was a sushi restaurant formerly operating in Cary, North Carolina. Ãn characterized its employees as either “front-of-the-house” or “back-of-the-house” staff. Servers and Server Assistants, who fell in the “front-of-the-house” category, received compensation from four sources: (1) an hourly wage of at least $2.13 for the first forty hours of the week and at least $5.76 for all additional hours; (2) cash tips; (3) credit card tips and (4) automatic gratuities. Ãn generally applied an automatic gratuity of 20% to the bill for parties of six or more people.
In July 2014, Ãn implemented a tip pool for its evening shifts. That tip pool included Captains, Servers, Bartenders, Sushi Chefs, and Server Assistants/Runners/Expediters. In addition, the Hostess received 100% of all tips received from to-go orders. Under this system, many of the Servers were paid so well that they surpassed the income of the restaurant’s managers. Plaintiffs Wai Man Tom and Brandon Kelly, who held the position of Captain (the most experienced servers), filed suit, claiming that their employer operated an unlawful tip pool because it included individuals who did not customarily and regularly receive tips. Moreover, they argued, the automatic gratuities were a form of tips. Therefore, because the tip pool was invalid, the restaurant was not entitled to take a tip credit and, without including the tips or the automatic gratuities, failed to satisfy its minimum wage and overtime obligations under the FLSA. Ãn countered that the automatic gratuities were not tips but instead were commissions under 29 U.S.C. § 207(i), entitling it to invoke the “commissioned salesperson” overtime exemption. Regardless, added the restaurant, its tip pool nevertheless was valid during those weeks where the 207(i) exemption was inapplicable. The district court agreed with the defendant and entered summary judgment in its favor.
The Circuit Court Decision
On appeal, the Fourth Circuit agreed with the trial court that the 20% automatic gratuity was not a “tip” as defined under the FLSA. Reviewing the Act’s regulations, the Court of Appeals noted that a tip is “a sum presented by a customer as a gift or gratuity in recognition of some service performed for him . . . [the amount of which is] determined solely by the customer, who has the right to determine who shall be the recipient of the gratuity.” 29 C.F.R. § 531.52. Conversely, under the FLSA regulations, “[a] compulsory charge for service, such as 15 percent of the amount of the bill, imposed on a customer by an employer’s establishment, is not a tip,” but instead is a service charge that “may be used in [its] entirety to satisfy the monetary requirements of the [FLSA]” if it “[is] distributed by the employer to its employees.” Id. § 531.55(a)-(b). So, compensation that qualifies as service charges can satisfy the FLSA minimum-wage and overtime obligations.
In this case, concluded the Fourth Circuit, it was “undisputed that the customers did not have unfettered discretion to leave (or not leave) the twenty-percent gratuity.” Even though a customer could request that the service charge be removed or revised, ultimately that decision remained with the restaurant’s management. “Consequently, even if the Employees could prove that Ãn would occasionally waive the automatic gratuities, that fact would not be material as it still would not enable a reasonable jury to find the twenty-percent automatic gratuity was a tip.”
However, added the Court of Appeals, the district court erred in its application of the 207(i) exemption because that exemption applies only to the overtime obligations of the FLSA, not to its minimum wage obligations. Furthermore, this exemption requires that “more than half [of the employee’s] compensation . . . represents commissions on goods or services.” 29 U.S.C. § 207(i). In this case, the only way this majority-commissions threshold was met was if both the automatic gratuities and the tips were included in the calculation of an employee’s total compensation. Moreover, while the FLSA regulations make clear that “all compensation” must be considered in determining whether the majority-commissions requirement of 207(i) is met, 29 C.F.R. § 779.415, the district court had improperly omitted tips from the calculation. Therefore, the Court of Appeals remanded the case to the district court to determine whether, using the proper calculation, the automatic gratuities met the requirements of the 207(i) overtime exemption. In addition, because this revised calculation will be needed to determine whether the restaurant will have to rely on the tip credit to satisfy its minimum wage or overtime obligations, the Court of Appeals likewise remanded the issue of whether a valid tip pool existed, or was even relevant.